Chapter 28. Should You Invest in Companies That Repurchase Their Own Shares?
Companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value.
When a publicly traded company buys its own shares, the outcome is a smaller number of shareholders owning the business. Through repurchases, the company may signal that its shares are undervalued. Repurchases are also a tax-free method to return cash to shareholders. The academic literature supports the view that companies repurchasing their own shares are frequently undervalued. In an article in the Journal of Business published by the University of Chicago, Amy Dittmar concludes, "Firms repurchase stock to take advantage of potential undervaluation."
Share Repurchasing Is Good News
Suppose you and John jointly own a tract of ancestral land. You divide it into two equal parts for farming purposes. Each of you can farm whatever you want and keep the outputs. In his piece of land, John cultivates cotton. You use it for sugarcane. After several years, John proposes to buy your piece of the land at an attractive price. Whether you sell or not, it should be immediately clear that his cotton farming is doing well. Through his desire to increase his landholding, he has revealed to you that he is in a profitable business. Share repurchasing is similar.
Investors can infer that a company that repurchases its shares frequently ...